New rules for IRS audits of partnerships

Need for a change

On November 2, 2015, the Bipartisan Budget Act was passed, changing how partnerships will be audited by the Internal Revenue Service (IRS) for years beginning after December 31, 2017. Taxpayers can adopt the new rules earlier for tax years starting after the Act was passed. Instead of audit adjustments being assessed on a per-partner basis, they will now be determined and collected at the partnership level.

The Joint Committee on Taxation estimates the change will result in $9.3 billion of taxes collected over ten years. This may be true as partnership audits in the past have been challenging, requiring the IRS to go after hundreds or thousands of partners to collect on their adjustments, if the partnership did not elect to be taxed at the entity level (which few do). Complex multi-tiered partnership structures and allocation methods, as well as lack of automated procedures at the IRS, burdened the audit process further. Such limitations kept the IRS from putting resources into auditing partnerships:

• From 2007 to 2012, the IRS audited less than one percent of partnerships with assets in excess of $100 million (except for 2010 when the rate rose to 1.4 percent).
• During the same timeframe, they audited 20.6 percent to 27.1 percent of corporations with a similar asset-sized threshold.
• Partnership audits were less effective than corporate audits – 64 percent of large partnerships audited in 2013 had no changes to reported income or loss, whereas only 21 percent of corporations during that year netted the same no change result.

It is expected this will change. Beyond the federal level, many expect states will soon pass similar rules.

Partnership representative

The Tax Matters Partner concept created by the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) will be replaced by a Partnership Representative who will have the sole authority to bind the partnership and its partners in these audits. This may be a partner or anyone else with a substantial presence in the United States. Historically, the IRS spent a lot of time determining the Tax Matters Partner. Under these new rules, the IRS can appoint a Partnership Representative if one has not been identified by the partnership. Also, it seems partners will no longer participate in audits, will not have to be notified regarding audit developments, and may not be able to contest the results.